Brookfield Asset Management Inc. has announced:
that it has agreed to issue 8,000,000 Class A Preferred Shares, Series 38 on a bought deal basis to a syndicate of underwriters led by TD Securities Inc., CIBC, RBC Capital Markets and Scotiabank for distribution to the public. The Preferred Shares, Series 38 will be issued at a price of C$25.00 per share, for gross proceeds of C$200,000,000. Holders of the Preferred Shares, Series 38 will be entitled to receive a cumulative quarterly fixed dividend yielding 4.40% annually for the initial period ending March 31, 2020. Thereafter, the dividend rate will be reset every five years at a rate equal to the 5-year Government of Canada bond yield plus 2.55%.
Brookfield has granted the underwriters an option, exercisable until 48 hours prior to closing, to purchase up to an additional 2,000,000 Preferred Shares, Series 38 which, if exercised, would increase the gross offering size to C$250,000,000. The Preferred Shares, Series 38 will be offered in all provinces of Canada by way of a supplement to Brookfield’s existing short form base shelf prospectus.
…
Brookfield intends to use the net proceeds of the issue of Preferred Shares, Series 38 to redeem its Preferred Shares, Series 12 and for general corporate purposes. The offering of Preferred Shares, Series 38 is expected to close on or about March 13, 2014.
Brookfield is up to its usual tricks – taking a very long initial fixed rate period (just over six years) in order to choose a higher yielding Canada bond as the basis for the reset.
The issue appears reasonably fairly priced against its peers, when examined with Implied Volatility Theory – but the implied volatility of 40% renders the conclusion a little suspect. Make of it what you will.
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Can you please expand on the latter part of the quote?
In order for a FixedReset to qualify as Tier 1 capital for banks and insurers, there must be no ‘step-up’ clause which might essentially force the bank to redeem early on economic grounds. Thus, a bank can’t issue a 4%+1000 FixedReset, because the enormous expected rate after reset will cause an expectation that it will be redeemed and it’s supposed to be permanent capital.
For marketing purposes, underwriters insist that:
– the reset credit spread should not be lower than it is at issue
– that the term to first call be more than five (due to regulations) and less than six and a half (due to a desire for uniformity) years.
– that these strictures apply to non-regulated entities as well, even though there’s no regulatory involvement. People already complain that preferred shares are too complicated, though how anything can be described as ‘complicated’ when all the information necessary is in the prospectus is quite beyond me.
The only wiggle room is the choice of the initial fixed-rate period. However, the Canada against which the spread is calculated will have the same term as this period (it might be an interpolation between two Canadas).
In practice, people buy these things on the basis of their initial dividend rate because, as we know, 90% of investors are morons. So while BAM and the underwriters were able to agree on 4.40%, the Issue Reset Spread didn’t really matter all that much, as long as it fit the other rules.
If we look at Canada yields for March 5 we find:
GOC5 = 1.67%
GOC7 = 1.98%.
So, assuming the calculations are based on these numbers, then if the initial rate had been 4.40% for a five year term, the Issue Reset Spread would have been 273bp.
If the initial rate had been 4.40% for a seven year term, the Issue Reset Spread would have been 242bp … but the underwriters won’t allow a seven year initial term.
So they were able to find Canadas trading with a term of six-and-a-bit years at 1.85% and marked the Issue Reset Spread off that bond.
Thank you.